What Is Actual Cash Value?

Actual cash value is one method of establishing the value of insured property to determine how much an insurer will pay the policyholder in the event the property is lost or damaged. Actual cash value is typically calculated by subtracting depreciation from replacement cost at the time of the loss. In other words, actual cash value accounts for age and wear and tear when the insured, damaged property needs to be replaced.

Insurers use depreciation to calculate actual cash value (ACV). Depreciation is an accounting concept that spreads the value of an item over its expected useful lifetime. Insurance companies use a similar concept, but they approach the calculation differently from accountants. Insurance companies calculate depreciation based on the property’s condition when it was lost or damaged, what a new item would cost, and how long it would typically last.

For example, if your home floods and you lose three laptops, your insurer would consider the cost of similar laptops at the time of the loss. They would also consider the expected life of the laptops to determine depreciation. If the expected life of each laptop was three years, and your laptops were two years old, and the replacement cost value is $1,000, the actual cash value formula would look like this:

$1,000, the actual cash value formula would look like this: $1,000 – depreciation (67% of $1,000) = $330 actual cash value per laptop

Replacement cost value means your insurance policy will pay the cost to repair or replace your damaged property without deducting for depreciation. In other words, it’s the cost of replacing something with a new version, at today’s market prices, or the current price at which an asset can be bought or sold.

Determining replacement cost for belongings is simple – it’s estimated by figuring out what the same or similar item costs to buy today. Figuring out the replacement cost of your home is a little more challenging, since it factors in the cost of the materials and labor required to rebuild the structure, and maybe even to bring the dwelling up to current building codes, depending on the policy. 

It’s important to note that the replacement cost for a home is just the cost of rebuilding it and replacing damaged belongings that were inside of it, not what you paid for the house. Therefore, replacement cost doesn’t consider things like a neighborhood’s desirability or the value of the land, both of which may drive home prices higher. Nor does it factor in the state of the housing market, which could also inflate the cost of buying a home. Replacement cost value is simply the cost of materials and labor.

When you buy homeowners insurance and other types of property insurance, you might have to choose between actual cash value and replacement cost value coverage. Before you do so, it is important to consider the pros and cons of each and to fully understand how your policy will pay.

Many home insurance policies cover your home at replacement cost value by default. For example, if a covered event demolishes your home and your policy’s dwelling coverage is $450,000, you may receive up to that amount to rebuild or repair your home.

Your belongings, meanwhile, are covered under personal property coverage within your homeowners insurance policy. When you insure the things you own inside your home, you may be able to choose between actual cash value and replacement cost value. Many insurance policies provide coverage for personal belongings on an actual cash value basis.

For some people, replacement cost might be the preferred option because it restores your situation to what it was before your covered loss occurred and doesn’t subtract depreciation. That also means you are protected against material and labor cost increases, which is especially important in times of high inflation. However, replacement cost value policies often cost more.

Actual cash value coverage may be less expensive, but it may not offer financially sufficient coverage if you suffer a loss. With actual cash value, you would need to make up the difference between the depreciated value and replacement value if you want to replace your belongings.